Covid-19: How distributors should respond

In leveraging multiple decades of combined channel experience across Asia Pacific, this guide is designed to help distributors overcome market challenges related to Covid-19.

This article outlines the risk distributors will typically face during this crisis period, and the actions they can take to address such issues.

From growth to the next growth cycle

Before Covid-19, the overall IT market was experiencing solid growth as the chief contributor to digital transformation deployments at customer level. But then in a matter of weeks, Covid-19 rocked the industry - simultaneously interrupting both the hardware supply chain (mainly out of China) as well as weakening overall customer demand.

This means that many distributors are experiencing an acute drop in demand for products and services, with the hope that recovery will arrive by the second half of the year. The overall hope is that the business does not contract on a full-year basis.

At this time, it’s worth noting that the current crisis (and likely recession) will not last forever. As experienced during other crisis periods, this will also pass and one day the channel and distributors will revert back to supporting digital transformation growth.

How a distributor navigates this current period will have a significant impact on how well they emerge from the crisis however, with the aim of taking advantage of the business recovery that will follow.

Our experience suggests that distributors with strong, hands-on and responsive management teams will emerge the strongest. But others will struggle for survival, especially if access to capital is limited.

If the crisis lasts longer than a few months they might also run the risk of becoming consolidated or unviable. Niche entrepreneurial distributors are typically very nimble with the owner in the saddle and highly scalable cost structures - they might come out relatively unaffected.

Impact on distribution

During the current crisis, distributors will face many risks and challenges, including:

1 - Supply chain impact: Given that Covid-19 hit China first, the hardware supply chain was disrupted immediately with some product categories impacted by shortages. This can lead to an inability to fulfil larger projects resulting in legal disputes, payment delays and in some cases penalty payments.

In general, fill rates will suffer and huge inventory imbalances will take place. Influential distributors will manage preferential allocations from vendors for shortage items.

2 - Revenue impact: Multiple factors will combine to impact revenue adversely. Inward and outward supply chain disruptions, demand shrinkage and lack of field activity will be primary drivers. It’s likely that credit insurers will reduce channel limits creating further pressure while the downstream cashflow crunch will also impede business and enhance risks.

Overall revenue will likely see a year-over-year decline due to a drop in customer demand - the size of decline will depend upon the length of the crisis. In addition, distributors will see a shift in sales mix as not all product areas become impacted in an equal manner. This will impact sales and inventory planning, resulting in too much inventory for some products while being 'stock-out' on others.

Distributors will also experience a shift in the customer mix as more businesses move online given the current situation which can impact reseller and margin mix. Some new opportunities will emerge from hurriedly implementing business continuity plans for customers, alongside increased enablement due to work from home policies.

3 - With simultaneous pressure on both supply and demand complicated by business mix shift, EBITDA is likely to come under pressure.

4 - Working capital will become constrained and cash flow planning will face challenges. This results in pressure on profitability and less clarity around the financial outlook.

5 - Reduced EBITDA coupled with poor cashflow may create a breach of banking covenants for highly leveraged distributors. In any case, banks would note the deteriorating industry prospects and increased risk and may reduce funding lines available.

6 - Given a declining and less predictable financial outlook the financial risk (including bad debt) associated with distribution is increasing, potentially leading to less favourable insurance terms of financing options available at a time when it is needed most.

7 - As work from home becomes the new normal for working, decision cycles will become slower with workflows, systems and tools typically not optimised for this engagement model.

Distributors may face multiple challenges and individual context will determine what actions are most important to consider. Below are activities distributors should consider to help mitigate against the adverse impact of Covid-19:

1 - Overcoming revenue related challenges:

a. Shift business focus and resources to product areas with more predictable availability, higher sales velocity and margin to maximise revenue and profit (e.g. products and services under demand to cater to the increased work from home requirements).

b. Review the pipeline and work closely with resellers and vendors to close larger projects, which often account for 25-30 per cent of a distributor’s business.i. If required, work with resellers and customers to renegotiate order completion and payment terms for larger deals.ii. If required, work with resellers and vendors to determine who best can take on customer credit for larger deals to ensure the transaction can be closed.

c. Implement financing and business models to support deferred customer payments (e.g. as-a-service solutions, consumption-based selling, leasing models etc) catering to customer requirements in terms of reduced capex spending. Work closely with vendors to enable this and leverage programs and capabilities in this area.

d. Focus on resellers with strong management, financial resilience, a loyal customer base and healthy pipeline as they will continue to do well and gain share during this period of crisis. Consider to selectively increase credit to the stronger resellers potentially with the support of increased vendor credit terms.

e. Keep adequate focus on project business from the government sector and large enterprise. It’s unlikely this segment will change its investment plans in the short-term.

In fact, governments are making available significant budgets to manage the crisis. Technology always gets a share of such spend as it’s vital in the execution of large-scale plans. For example, setting up new hospitals, quarantine zones or public communication systems.

f. Consider invoicing some large deals direct to end customers, in agreement with resellers and covering them for margins, in situations where reseller credit inability may jeopardise pipeline business.

g. Reset sales targets and the commission schemes for internal sales to ensure targets are fair to keep motivation and hunger high.

h. Ensure the virtual and online business processes are in place to handle reseller, vendor and internal processes in a fast and agile manner. If required, invest as appropriate in these processes to handle such requirements.

a. Work with vendors to reset targets for rebates and MDF program objectives to retain vendor investment in terms of per cent of sales. This is important as vendor rebate and MDF contribution to EBITDA is often in the 30-50 per cent range. Negotiate with vendors to use MDF to retain vendor dedicated resources for an interim period.

b. Focus on products where rebate targets are achievable and where inventory and supply chain are predictable.

c. Focus on higher margin product categories (e.g. software and services) which are unlikely to be impacted by supply chain disruptions.

h. Only consider structural headcount adjustments in areas where the crisis is expected to have an impact for a minimum of one year. Redundancy related cost as well as the later cost of hiring will otherwise exceed the short-term savings.

3) Working Capital initiatives:

a. Vendors and accounts payable:i. Seek vendor support for extended payment terms. Especially for larger deals or in cases when vendor deliverables (products or services) are not complete.ii. Follow-up with vendors to ensure prompt payment of rebates and MDF, while settling any disputes quickly to release payments.iii. Expedite returns of any authorised and excess inventory to vendors. Seek to take advantage of vendor consignment programs where available.iv. Be careful on-boarding new vendors with unproven credentials and those with a lack of transparent and consistent policies. Do not allow exposure (e.g. claims receivable, excess inventory with advance payment etc) to build up with such vendors. Remember some vendors may not survive this crisis too.

b. Resellers and accounts receivable:i. Follow-up with resellers on payment before due date. Early engagement is important to get paid if reseller financials are constrained. In general, increase the frequency of accounts receivable review and risk mitigation given higher bad debt risk.ii. Support resellers in moving any excess inventory they might have to other resellers who can sell the products to reduce reseller working capital requirements.iii. Implement a differentiated accounts receivable policy based on reseller financial capabilities (e.g. implement cash discount for cash rich retailers while providing longer terms to corporate resellers who serve customers with long payment terms).iv. Settle small amount disputes with resellers quickly if they are holding up larger payments for this reason.v. Leverage bank or vendor sponsored financing programs towards more disciplined reseller partners.

c. Inventory Management:i. Focus sales on inventory at hand and products with high sales velocity.ii. Work closely with vendors to balance inventory mix aligned to sales mix to achieve a minimum inventory level. Where possible return excess inventory to vendors and take advantage of vendor consignment programs. This is an excellent time to bring down inventory for slow moving products or aged inventory.iii. Review and control delivery patterns from vendors. Avoid vendors dropping large inventory at the end of the quarter which will then sit on your balance sheet.

4) Capital expenditure:

a. Reduce and delay planned capital expenditure where possible.

5) Corporate financing initiatives:

a. Increase vendor financing where possible.

b. Pro-actively engage with banks and other debt holders to explain the strategy of managing the business and plans to seek support for increased debt if required. Pro-active and transparent engagement can often prevent businesses falling victim to banks taking a unilateral decision to reduce credit lines.

c. Look to increase capital injection from shareholders if required

6) Consider M&A:

a. The distribution landscape is going through a consolidation phase. In times of crisis, valuations are often under pressure and M&A opportunities will develop. For those looking to buy or sell, a crisis period might be helpful, pending the acquisition partner has access to capital.

Planning for business recovery:

Covid-19 will one day come to an end and business will re-accelerate again. Here are some actions and initiatives that distributors should consider when planning how to emerge fast and strong from the crisis:

1 - Plan with core vendors and resellers for how best to re-accelerate the business when the market normalises again. Leverage business intelligence capabilities to identify appropriate customer, partner and product segments to focus on. Ensure programs and initiatives are designed and ready to go.

2 - As the crisis teaches leaders how to run a business with lower capital and operating costs, retain those practices and learnings even in good times.

3 - Use the period of lower sales activities to ensure the skills and capabilities of the team is enhanced. Execute, review and enhance all training and certification levels working closely with high priority vendors to ensure the team are ready when the business recovers.

The Chinese word for crisis is composed of two characters - one representing danger and the other opportunity. During such a period of crisis there are many opportunities to out-smart and out-compete competitors while handling danger.

Through acting wise, fast and decisive, the best distributors will often emerge stronger after a crisis while other might lose out.

Shailendra has over three decades of experience leading large multinational technology distribution businesses, alongside extensive industry M&A, integration and restructuring experience. He is also co-founder of Peer Connexions, a platform to digitally transform distribution models for vendors.

Joergen is a board member, business advisor and consultant leveraging more than 30 years of experience from multiple large global technology vendors. His consulting practice is mainly focused on business performance management, leverage of partner eco-systems for profitable growth, and optimising organisational and individual performance in a culturally diverse environment.

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